China’s video gaming - A force to be reckoned with

Video gaming is a serious business. By the end of 2019, it is estimated that the global video game market will generate USD 152.1 billion in revenue (see Fig. 1), with 45% from games being played on mobile devices (smartphones and tablets). Improved mobile connectivity has led game publishers to shift to a subscription-based online revenue mode, and thereby capitalise on sources of income previously untapped due to piracy concerns.

Fig.1: Global video gaming revenues (breakdown by devices, USD billion)¹

This impressive growth of income includes not only content and rights fees, but also broadcast licencing revenues and sales of in-game virtual tools. Considering all this, the associated revenue is forecast to grow further and is expected to reach USD196.0 billion in 2022.

Within this lucrative industry, China has the world’s largest video game market by revenue and gamer population. Yet, the annual average revenue per user (ARPU) remains at a staggering low of USD55.5, which is far below the USA and Japan, as well as other smaller economies (see Fig. 2).

Fig. 2: Top five video game markets in the world²

This discrepancy represents substantial room for market expansion. As China continues to develop, its GDP per capita will rise, as will the ARPU for video games. If China’s ARPU can match Germany’s ARPU of USD106.1 (a very conservative benchmark), then the size of its video game market could potentially increase to USD65.7 billion, thereby creating a huge market that investors simply cannot afford to overlook.

So, what is behind China’s phenomenal potential? The answer lies, in large part, in China’s ‘mobile-first’ landscape, together with its huge population of video gamers. This makes the country’s video game industry more likely to access revenues from digital sources, which typically have higher margins compared to the bricks-and-mortar businesses which the US market is tilted towards.

In 2018, China had a total of 458.8 million mobile gamers, outnumbering the 190 million in the US⁴. Such a vast mobile gaming population can be seen in China’s 66.8% share of mobile game platforms as well as the blistering growth in the mobile games market. As shown in Fig. 3, China’s mobile games market grew by 10.5% to USD23.2 billion in 2018, despite a nine-month freeze on new game approvals.

Fig. 3: Revenue of China’s mobile games market (USD billion)⁵

Furthermore, with the advent of 5G mobile services and highspeed data transfer, video games with complicated graphics and storylines could be streamed and played via low-powered devices. This will be a shot in the arm of China’s mobile games market. All of this will provide fertile ground for the entire value chain – development, publishing, and distribution – of China’s video game industry (see Fig. 4). Hence, a plethora of investment and growth opportunities are now available in the sector.

Fig. 4: Value chain of China’s video game industry⁶

In China, the development and publishing sectors are dominated by a small number of large video game conglomerates. Simply put, these players can search for the best price-output combination, and thereby enjoy higher earnings. For this reason, shares of these growth companies – listed on the Hong Kong exchange, Shenzhen exchange or represented in the form of American depository receipts (ADR) – usually trade at a premium over the broader Chinese stock market.

Over in distribution, there are various channels to end-users: game portals, social media, live and streaming broadcasters and eSports events. With the potential income generated by tournaments, sponsorship, media rights, and money earned by teams and players, the eSports segment plays an integral role in video game conglomerates’ expansion in the long term.

No longer seen as a childish pastime, video gaming has evolved into a profession known as eSports (electronic sports). This form of competitive gaming has a professional league structure – though still in its nascent stages – which draws a large audience comparable to traditional professional sports.

The 2017 League of Legends World Championship, for example, held in Beijing, drew an estimated 106 million viewers from online streaming services with 98% of the viewers from China⁷, a number on par with the television audience of the Super Bowl. Such success has helped China’s eSports receive international acclaim in recent years, according to a study by Penguin Intelligence⁸.

China’s eSports gamers are usually young and well educated. China’s eSports events are also widely acclaimed for their organisation and development. A study by Bank of America Merrill Lynch estimated that China’s eSports has an audience of 329 million in 2019, and that total eSports market revenues are estimated to reach USD236 million in 2019, up 34% from a year ago (see Fig. 5).

Fig. 5: China’s eSports revenues (USD million)⁹

We see eSports as a positive development for the online game industry as it brings different stakeholders together to generate more user attention and engagement. This represents significant potential for adverting/sponsorship, paid-subscriptions for premium content, as well as new revenue models from different eSport value chains such as data analytics, talent cultivation and offline events (gaming spaces).

Current valuations of China’s video game stocks appear more reasonable. They sold off significantly from March 2018 to July 2019 following concerns over earnings downgrades after the ban on new game approvals. The sell-off has brought the average forward price-to-earnings (P/E) of China’s 16 major video game stocks (that we follow) down below the 5-year average (see the red dot in Fig. 6).

Fig. 6: Valuations of China’s video game stocks (5-year)¹⁰

Note: Average forward P/E of 16 China's listed video game stocks (7 in Hong Kong, 5 in Mainland China, 4 in the US).

Despite the more reasonable valuations and the growth trajectory, there are, however, risk factors. China’s video game stocks have higher business risks, compared with utilities and consumer staples, since their cash flows are less predictable. Often there is limited visibility as to how upcoming video games will perform.

As for eSports organisers, streaming broadcasters, and other companies in the distribution value chain, the sector remains complicated and fragmented (see Fig. 4). Many of them are privately owned and are thus under-researched, as well as having opaque financials. Yet, as eSports becomes mainstream, we expect to see more visibility.

It is early days whether eSports will be a medal event at the 2022 Asian Games in Hangzhou, China. In the lead-up to the games, it will not be surprising to see more initial public offerings from Chinese video game companies, thereby expanding the investment universe across the board.

All in all, asset managers who can understand the implications of China’s changing regulatory trends and identify emerging leaders are well positioned to tap into the full potential of China’s booming video game and eSports markets.